Royalty Tax Before Franchising Your Business

Before offering a franchise, you need to be clear not only about how much the royalty will be, but also how it will be collected, recorded and treated for tax purposes. The amount stated in the agreement may differ from what actually reaches your bank account because of tax withheld. A well-organised process helps franchisors and franchisees avoid incorrect charges and payment disputes.

1. Have each type of payment reviewed

Do not group everything you receive from a franchisee under “royalties”. Payments may cover the use of the brand and system, separate services, product purchases or equipment. The substance of the transaction matters: the name given to a fee is not enough to determine its correct tax treatment.

Prepare a schedule with your accountant. For each payment, record:

• The purpose of the payment and what is provided in return.
• The person or business receiving and making the payment.
• The basis of calculation and billing date.
• The document to be issued and supporting evidence to be received.
• Potential taxes and who is responsible for withholding or remitting them.

Have your accountant assess how the business structure, tax status and type of income affect each transaction. Do not simply copy another brand’s approach: its circumstances may differ even if both businesses operate franchises.

The main legal basis for taxation in the Philippines is the National Internal Revenue Code, together with its amendments and the applicable rules of the Bureau of Internal Revenue (BIR). Payments made under a single agreement do not automatically receive the same tax treatment.

2. Align the agreement with the calculations

Your lawyer, accountant and the person responsible for collecting payments should share the same understanding of the agreed fees. If the royalty is a percentage of sales, define what “sales” means for this purpose. Does it include tax on sales? How will product returns, cancelled transactions and discounts be treated?

A separate question is whether the stated fee includes applicable tax or whether tax will be added. Also clarify how any tax that the payer must withhold will be recorded. A lower amount reaching the bank does not necessarily mean an underpayment; tax may have been correctly withheld, but this must be supported by evidence.

The Philippines has no single comprehensive franchise law, but specific regulations do apply. Executive Order No. 169, series of 2022, sets minimum content and Department of Trade and Industry (DTI) registration requirements for franchise agreements involving micro, small and medium-sized enterprises that fall within its scope. These include full disclosure of fees. This does not replace compliance with tax law.

The Civil Code also applies to contractual obligations, while the Intellectual Property Code, or Republic Act No. 8293, governs the licensing of brands and related rights. Have the tax clause reviewed alongside these requirements, rather than adding it only when collection problems arise.

3. Set up a process from billing to supporting evidence

Establish a monthly process that both parties can follow. This might begin with confirming the basis for the royalty, followed by checking the calculation, issuing the correct documentation, making payment and reconciling the records.

Assign responsibility for each step. Who will issue the billing document? Who will verify the funds received? Who will request and check evidence of tax withheld, where applicable?

Ask your accountant to confirm the correct use of BIR Form 2307 or other required evidence, depending on the type of withholding. Not all withheld taxes require the same documentation or receive the same treatment. Follow the current BIR rules on issuing sales documents too; do not rely solely on an old template.

In each franchisee’s account, record the total charge, applicable tax, amount withheld, net amount received and outstanding balance separately. Reconcile these against bank records and supporting documents. If there is a discrepancy, send a clear explanation and calculation, rather than simply issuing another bill.

4. Test the process before collecting the first payment

Run a sample billing month using the rules you intend to include in the agreement. Cover common scenarios: a standard payment, returned sales, tax withheld and supporting evidence received late. You do not need to collect any actual payments to identify a confusing process.

Ask the team to answer three questions: How much should be billed? How much is expected to reach the bank account? What documentation is needed to confirm that the balance has been settled? If their answers differ, resolve the inconsistencies in the agreement and procedures first.

Practical reminder: Before receiving your first royalty payment, have checked calculations, correct documentation and clearly assigned tax responsibilities in place. It is easier to establish a sound collection process than to correct inaccurate records after a franchisee has opened for business.